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Changing banking policy is key to improving customer outcomes

COBA Comments: Sally Mackenzie explains how the ‘major banks’ set their own rules and dampen competition

In any competition you want to ensure that all players have an equal chance of winning. Australia’s banking sector is no different. Australian consumers can rest assured that credit unions, mutual banks and building societies are all subject to the same broad regulation as the major banks.

However there are some differences which make it unfair for smaller institutions to compete with the Big Four. One of the most significant differences relates to the most important loan that most Australians will take out – their home loan.

To help keep stability in the banking sector, one of the banking regulators – the Australian Prudential Regulation Authority (APRA) – makes rules that tell banks, credit unions and building societies to put some money aside to cover losses in case the borrower defaults on their loan. This is called ‘capital’.

The amount of capital that must be set aside for each loan is based on its ‘risk weight’. The more risk that a loan has, the higher its risk weight. A higher risk weight means a bank has to hold more capital. The rules around figuring out risk weights are different for the big banks compared to other banking institutions.

The major banks can set their own risk weights for each home loan, provided the average risk weight they set aside is 25 per cent across all home loans. For some loans, which the Big Banks decide are very low risk based on their models, they might only set aside five per cent or six per cent.

For challenger banking institutions, the regulator APRA sets these risk weights. The result is an average risk weight is 39 per cent across all the home loans, with the lowest possible risk weight for any individual loan set at 35 per cent. This amount is regardless of the actual risk of default on each home loan!

For example, imagine two identical home loans, on identical properties taken out by borrowers with the same likelihood that they would default on the loan, as shown in the table below.

                                                   Home loan value   Interest rate  Probability of default Risk weight
Big Bank 400,000 3.9% 0-0.1%  5 or 6%   
Challenger Bank  400,000 3.9% 0-0.1%  35%


In practice, this means that the major banks are more than $1,000 better off per year for a $400,000 home loan. As you can imagine, this adds up over the life of a 30-year home loan.

So, why should this matter for consumers?

It’s true that consumers don’t pay directly for this or would even notice this difference. After all, customer owned banking institutions have very competitive prices.

However, if it is costing challenger banking institutions more to make the loan, this means they have less to invest in products and services that customers value. This is money they might otherwise invest to attract new customers, which would help them grow and compete with the major banks.

The major banks already dominate the market – they don’t need another unfair advantage.

A report released by COBA found that APRA should look at closing the gap so that there is less of a difference between the risk weights for Major Banks and challengers.

If Australia’s regulators and politicians are looking for a simple way to start improving competition, this would help level the playing field.

Sally Mackenzie is Director Strategy and Stakeholders at the Customer Owned Banking Association. She leads COBA’s lobbying and advocacy agenda, working to achieve a more competitive banking market.

Sally has worked in the public and private sectors across the Asia Pacific. She has worked in banking and finance domestically and off-shore for NSW Treasury and as an advisor to the Thai, Philippines and Mongolian governments. She is also an experienced diplomat, having worked in the Australian Embassy in Jakarta and High Commission in Honiara. Sally also served as Deputy Chair of the Canberra Rape Crisis Centre.

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